SEC's Top Risk Cop Named Just As CDS Market Comes Back

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The credit default swap market is getting its swagger back, just as a new sheriff is coming to town.

Bloomberg notes that the the cost of the debt swaps are down to pre-crisis levels.

A year after the bankruptcy of Lehman Brothers Holdings Inc., credit-default swaps have lost their stigma for disaster and are contributing to the growing confidence in the credit markets.

The cost to protect against a failure by New York-based Goldman Sachs Group Inc., Charlotte, North Carolina-based Bank of America Corp., and 12 of the other biggest derivatives dealers dropped 66 per cent in the past six months, according to an index of swaps compiled by Credit Derivatives Research LLC. While the U.S. struggles with the slowest recovery since 1945, the market where investors protect themselves from default and speculate on corporate debt shows confidence is the highest since June 2008.

That comes as the SEC confirmed its new risk czar would be Dr. Henry Hu, an expert on the dangers of derivatives.

Reuters: The U.S. Securities and Exchange Commission is establishing a new division to help the agency better identify risks and trends in financial markets.

University of Texas School of Law Professor Henry Hu will head the Division of Risk, Strategy, and Financial Innovation, the SEC said on Wednesday.

As we’ve noted, Hu has been critical of the systemic risk posed by sophicticated securities and credit derivatives. Here’s a Financial Times summary of his research from January 2008:

FT: A boom in the use of derivatives is giving creditors strong incentives to push troubled companies into bankruptcy rather than help rescue them, according to new research and industry experts.

A study by academics Henry Hu and Bernard Black concludes that, thanks to explosive growth in credit derivatives, debt-holders such as banks and hedge funds have often more to gain if companies fail than if they survive. The study suggests this development could endanger the stability of the financial system.

While default swaps alone don’t kill companies, there’s still a push for regulation. And as the CDS market roars back, Dr. Hu will as his hands full.

As Bernie Madoff-whistleblower Harry Markopolos warned, CDS fraud could make Madoff’s $65 billion theft “look like small-time.”

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